18 - 1

COST CONCEPTS AND PRINCIPLES

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C2 Types of Cost Classifications

Classification by Behavior
Cost behavior refers to how a
cost will react to changes in
Cost

the level of business activity.

• Total fixed costs do
Activity not change when activity
changes.
Cost

• Total variable costs change

in proportion
Activity to activity changes.
• Mixed costs are
combinations of fixed and
Cost

variable costs.

Activity
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C2 Types of Cost Classifications

Classification by Traceability
Direct costs Indirect costs
 Costs traceable to a  Costs that cannot
single cost object. be traced to a
single cost object.
 Examples: material
and labor cost for a  Example: A
product. maintenance
expenditure
benefiting two or
more departments.
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C2 Types of Cost Classifications

Classification by Controllability
The degree of control depends on the
level of management in the organization.
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C2 Types of Cost Classifications

Classification by Relevance
Sunk costs have already been incurred and cannot be
avoided or changed. Sunk costs should not be
considered in decisions.
Example: An automobile purchased two years ago cost
$15,000. The $15,000 cost is sunk because whether the car is
driven, sold, traded, or abandoned, the cost will not change.

Out-of-pocket costs require future outlays of cash

and should be considered in decisions.
Example: You plan on buying a new car for $25,000 next month.
The cost of the new car is an out-of-pocket cost because you can
choose to spend or not to spend the $25,000 next month.
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C2 Types of Cost Classifications

Classification by Relevance
An opportunity cost is the potential benefit lost by choosing a specific action from two or more alternatives

Example: If you were not

attending college, you
could be earning $20,000
per year. Your opportunity
cost of attending college for
one year is $20,000.
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C3 Types of Cost Classifications

Classification by Function
Direct
Direct Material Manufacturing
Labor Overhead

Product

Period costs are expenses

not attached to the product.

Administrative costs are

Selling costs are incurred to
non-manufacturing costs
obtain orders and to deliver
of staff support and
finished goods to customers.
administrative functions.
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C3 Period and Product Costs

in Financial Statements
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C3 Identifications of
Cost Classifications

* Although an assembly worker’s wages are classified as variable costs, their actual behavior depends on how workers are paid and
whether their wages are based on a union contract (such as piece rate or monthly wages).
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C3 Cost Concepts for

Service Companies
The cost concepts described are generally
applicable to service organizations.

For example, the cost of

beverages for
passengers of Southwest
Airlines is a variable cost
based on number of
passengers.
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C3

Manufacturer’s Costs
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C3

Direct Materials

Direct material costs are the expenditures for

direct materials that are separately and readily
traced through the manufacturing process to
finished goods.

Example:
Steel used in the
frame of a
mountain bike.
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C3

Direct Labor

Direct labor costs are the wages and salaries for

direct labor that are separately and readily
traced through the manufacturing process to
finished goods.

Example:
Wages paid to a
mountain bike
assembly worker.
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C3

Factory Overhead

Factory overhead consists of all manufacturing

costs that are not direct materials or direct labor
and the costs cannot be separately or readily
traced to finished goods.

Examples:
Indirect labor – maintenance
Indirect material – cleaning supplies
Factory utility costs
Supervisory costs
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C3

Prime and Conversion Costs

Manufacturing costs are often
combined as follows:

Direct Direct Manufacturing

Material Labor Overhead

Prime Conversion
Cost Cost
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C4 Reporting Manufacturing
Activities
 Merchandisers . . .  Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

SaleMart
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C4

Manufacturer’s Balance Sheet

MERCHANDISER MANUFACTURER

Current Assets Current Assets

 Cash  Cash
 Receivables
 Receivables
 Inventories
 Merchandise Raw Materials
Inventory Goods in Process
Finished Goods

The primary difference is inventory.

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C4

Manufacturer’s Balance Sheet

Raw Goods in Finished

Materials Process Goods

Materials Partially complete Completed

waiting to be products. products
processed. for sale.
Material to which
Can be direct some labor and/or
or indirect. overhead have
been added.
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P1

Manufacturer’s Income Statement

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P1 Cost of Goods Sold for a

Merchandiser and Manufacturer
Cost of goods sold for
manufacturers differs
only slightly from cost
of goods sold for
merchandisers.
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C5 Activities and Cost Flows

in Manufacturing
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P2

Manufacturing Statement
Summarizes the types and amounts of costs
incurred in a company’s manufacturing process.

Direct Materials Used

+ Direct Labor
+ Factory Overhead
= Total Manufacturing Costs
+ Beginning Work in Process
– Ending Work in Process
= Cost of Goods Manufactured
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P2

Manufacturing Statement
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P2

Manufacturing Statement
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P2

Manufacturing Statement

Include all direct labor costs

incurred during the current period.
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P2

Manufacturing Statement
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P2

Manufacturing Statement
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P2 Overhead Cost Flows Across

Accounting Reports
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C6

Trends in Managerial Accounting

Customer Global
Orientation Economy

Service
E-Commerce
Economy

Lean Practices Value Chain

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C6

Customer Orientation
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C6

Total Quality Management

Quality improvement Seek and uncover
applied to all aspects of waste.
business activities.

Constant Focus on
Higher Standards

Employees encouraged Company emphasizes

to try new methods value of quality through
to improve quality. quality awards.
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C6 Just-In-Time (JIT)
Manufacturing
Receive
customer Complete products
orders. just-in-time to
ship to customers.

Schedule
Production.

Receive materials Complete parts

just-in-time for just-in-time for
production. assembly into products.
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C6

Value Chain

The value chain refers to the series of activities that

add value to a company’s products or services.
Companies can use lean practices to increase
efficiency and profits.
 18 - 34

A1

Raw Materials Inventory Turnover

Raw Materials Used
Raw Materials
Avg. Raw Materials
Inventory turnover =
inventory
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End of Chapter 18